Monetary Freedom

Sunday, February 4, 2018

The recent tax bill signed by President Trump reduces the corporate income tax rate from 35% to 21%. This was a positive change, but really, just a step in the right direction. The corporate income tax rate should be zero.

All corporate income belongs to people and it is the people that matter. My point here is different from the economic theory of tax incidence. To the degree people change what they do to reduce their tax burden, part of that burden is shifted to other people. Usually, total income and welfare is also reduced. When a tax is reduced, the reverse of that logic is that effort to reduce the burden is curtailed and part of what was shifted disappears. This benefits someone against whom the tax was not directly assessed while increasing total income and welfare.

There is almost certainly some shift in the incidence of the corporate income tax, but the first step is to understand that the immediate burden of the corporate income tax is on the owners of the corporation--that is, the stockholders. There is little reason to have a special tax on the income stockholders earn from businesses organized using the corporate form and certainly no reason for a high tax of 21% much less 35% or even more.

While the average income of those owning shares of stock is relatively high, there are many stockholders who have quite modest incomes. Most obviously, many with defined contribution retirement plans use savings to purchase stock, sometimes indirectly through stock index funds. The corporate income tax reduces the return on these stock investments and so the income available to working people when they retire. Since this impacts the amount of saving necessary to generate an acceptable retirement income, it adversely impacts the consumption and welfare of average working people in the present. To avoid imposing unfair and unreasonable tax rates on people of modest means it is necessary to stop taxing corporations and instead tax the people who own the corporations. Those with lower incomes can then be taxed at a more modest rate.

Suppose a corporation pays out its profit as a dividend to its stockholders. Assume the share of the profit due to a stockholder is $100 The tax paid by the corporation was $35, leaving $65 for the stockholder's dividend. A individual with an average income might be in a 15% personal income tax bracket, leaving about $56. The government has taken nearly half of the share of the profit belonging to this taxpayer. After the recent decrease in the corporate tax rate, this would instead be $79 for the dividend. After paying the 15% tax rate on personal income, that would leave $67. The government is taking about 1/3 of the original $100 profit. But why?

Why shouldn't this average worker solely pay the 15% on this $100 as he or she would pay on any other income? While for most people that is wages, it also includes interest and profit generated from other business forms such as a proprietorship or a partnership.

It would be possible to impose an especially high tax on people earning high incomes from businesses organized as corporations, but that really doesn't make any sense either. Before the reduction in the corporate tax rate, the $100 profit would allow for a $65 dividend, which after the 39.6% top tax rate would result in about $40, so that the government is taking about 60% of the earnings. After the tax cuts, with the new lower corporate tax rate and the slightly lower top tax rate on personal income, the government will take slightly more than 1/2 of the earnings.

However, why should income from corporate profit be taxed at 50% while interest from bonds (including corporate bonds) or profit from proprietorships or partnerships be taxed at 37%? While I think the new top tax rate is too high rather than too low, having an especially high tax rate for income from corporate profit is unreasonable and unfair.

There is an important complication that could result from taxing personal income at a higher rate than corporate income. With no corporate income tax and a personal income tax, there is an incentive to use the corporate form to accumulate wealth without paying any tax. Conceptually, this can be corrected by allocating all corporate profit to the stockholders whether they are distributed as dividends or held as retained earnings. An alternative approach is to continue to tax corporations but to provide a refundable tax credit against each stockholder's personal income tax.

However, there is a good case to be made for expanding the ability to accumulate wealth without paying tax. From that perspective, the problem would be that the ability to do so is limited to those who buy and hold stock in a particular corporation. It should also be possible to accumulate wealth tax free for those who shift funds between corporations or keep money in a savings account or purchase bonds. Perhaps the easiest way to accomplish this administratively would be to remove the limits on deductions for contributions to IRA accounts as well as the penalties for early withdrawal. The result would be a shift from a tax on personal income to a tax on personal consumption.

Some would complain that taxing consumption is unfair because we all must spend some of our income on consumption and those with higher incomes have more left over that can be saved and so avoid tax. I suppose the argument just takes the tax rates as given, though I think that those making this claim are typically assuming a proportional consumption tax. That would be true of a typical sales tax.

However, a personal consumption tax can be applied at different rates. I favor a digressive rate structure. That is a tax system that includes two rates-- 0% for some initial level of consumption (or income) and then some other rate that applies to the rest. Of course, it can be equally described as a single tax rate that is applied after a standard deduction. So for example, a 10% tax rate applied on all consumption greater than $20,000. Such a tax system is progressive relative to consumption, because average tax rate rises with the level of consumption. With the given example, consumption of $10,000 would be taxed at a zero rate, consumption of $25,000 would be taxed at a .1*(25,000-20,000)/25,000 = 2%, consumption of $50,000 would be taxed at .1*(50,000-20,000)/50,000 = 6%, and consumption of $100,000 = .1*(100,000-20,000)/$100,000 = 8%. As consumption rises, the average tax rate approaches in common marginal rate of 10%.

How a tax on consumption relates to the income earned by the taxpayer would depend on the saving rate. However, be increasing the zero bracket and the tax rate, the average saving rate can be offset so that the tax system is progressive relative to income as well.

While it might seem that taxing consumption biases the tax system towards saving, the conventional wisdom in economics is that instead taxing income creates an inefficient bias towards current rather than future consumption. Economics assumes that the purpose of production is consumption. Income reflects contributions to production with its purpose being consumption now or in the future. Saving and the accumulation of wealth is the mechanism by which current production is used to provide for future consumption. Basically, the notion that taxing consumption is inefficient ignores that future consumption will be taxed as well, and that taxing investment income implies an excess burden from choosing to consume in the future.

While that argument is true as far as it goes, a given tax revenue requires a a higher tax rate on consumption than income (assuming private saving is positive in aggregate.) That higher tax rate on income will tend to discourage other economic activity--like working to earn income--compared to a lower tax rate.

Still, my own view is that earning income measures contributions to society and consumption is what is taken from society. I think it is better to tax what people take than what they contribute. I don't really agree with the principle that those who contribute and take more should pay more taxes, but I do believe that it is wrong to heavily tax people who take very little, especially when that is because they are unable to contribute much.

Regardless, taxing corporations because those who mostly own them are buying yachts and limousines is a mistake. It is possible to reform the tax system to greatly reduce the resulting unreasonable and unfair burdens placed on others.

Sunday, October 8, 2017

Nancy MacLean's Democracy in Chains follows its fictional introduction , the imaginary "Meeting in Dixie" with a prologue, "The Marx of the Master Class." There she claims that Calhoun was James Buchanan's "lodestar." As has been pointed out by others, there is a serious problem. Buchanan never cited Calhoun. He was hardly developing and elaborating on Calhoun's political insights.

Murray Rothbard, however, does cite Calhoun. He was quite gushing about some of Calhoun's ideas. Charles Koch at one time provided financial support to Rothbard and he also provided support for Buchanan. Surely, then, Rothbard and Buchanan's views can be conglomerated together as all so much propaganda for the Koch cause?

However, Rothbard and Buchanan were not at all on the same page. Phil Magness and Art Carden's review in Regulation cites private correspondence where Rothbard absolutely rejected Buchanan and Tullock's analysis in the Calculus of Consent.

More importantly, the very book by Rothbard that MacLean cites, Power and Market, includes Buchanan in its index. What did Rothbard say about Buchanan there? It is in the preface:

"In recent years, economists such as Anthony Downs, James Buchanan, and Gordon Tullock (many of them members of the Chicago School of economics) have brought economic analysis to bear on the actions of government and of democracy. But they have, in my view, taken a totally wrong turn in regarding government as simply another instrument of social action, very much akin to action on the free market. Thus, this school of writers assimilates State and market action by seeing little or no difference between them. My view is virtually the reverse, for I regarding government action and voluntary market action as diametric opposites, the former necessarily involving violence, aggression, and exploitation, and the later being necessarily harmonious, peaceful, and mutually beneficial for all."

MacLean apparently missed Rothbard's claim that his approach was totally different from that of Buchanan, and instead cites a section of his second chapter "The Fundamentals of Intervention" where he discusses Calhoun's analysis of taxation. Rothbard included a long quotation from Calhoun. From a "Virginia School" perspective, the quoted analysis of taxation is very incomplete. There is no mention of the benefits generated from whatever government service is being funded. From his earliest work in the late forties, Buchanan followed Wicksell in emphasizing the relationship between the benefit of the public expenditure and the tax cost to each person.

The only "benefit" mentioned by Calhoun is the receipt of tax funds. To use a 19th century example. suppose the government levies a tax to fund the construction of a fortress to protect a port. The contractor who builds the fort may also be subject to the tax, but if the total revenue from the government payment is greater than the amount of taxes he paid, then this contractor is a net tax consumer according to Calhoun. Meanwhile, suppose a cotton planter sells some small part of his crop to the government which uses it for the flag that goes on top of the fort. While the planter receives some tax money from the sale of this small amount of cotton, if the total amount of tax paid is greater than the amount earned from the cotton used for the flag, then this planter is a net taxpayer in Calhoun's view. According to Rothbard, the building contractor is necessarily exploiting the cotton planter.

What about the benefits provided by the fort? Perhaps it is protecting the port from pirates, resulting in lower shipping fees and increased income for the planter who uses the port to export cotton. And while it is certainly true that the particular contractor building the fort benefits from this business, determining the net benefit is not primarily a matter of subtracting off the contractor's tax payments but rather his opportunity cost--the value of the other construction projects the contractor has forgone. While the scenario of perfect competition that would reduce this net benefit to zero is unrealistic, in a competitive market the net benefit to the contractor might be quite small. Further, the added demand for construction services may increase the incomes of contractors doing private sector work, even though they receive no direct payment of tax monies.

Calhoun, of course, was no economist. Rothbard has less excuse for ignoring the opportunity costs of those selling to the government. However, the question is not really whether Calhoun or Rothbard (and Rothbard's more devoted libertarian followers) provided a reasonable analysis of taxation. The question is what does this have to do with Buchanan and public choice economics?

In the pages MacLean references, Rothbard accuses other free market economists of failing to see that taxation should be counted as intervention in the market. Surely, this should have signaled to MacLean that Rothbard wasn't simply repeating some standard view that could be attributed to any other economist, much less Buchanan. In fact, few economists share Rothbard's goal of defining and defending strict laissez-faire. Most economists, even those with free-market views, are not worried about whether taxation counts as government intervention. Few economists indeed would feel a need to argue that taxation is not government intervention in the market because if it were, it would be illegitimate. How many economists would argue that all government intervention is necessarily illegitimate? (My view is that taxation is government intervention, but that doesn't mean that it is not sometimes a necessary evil--the least bad option. I believe Buchanan would say that if it is the least bad option, then it cannot be described as any kind of evil, necessary or not, and instead must be described as a positive good, or at least optimal.)

It is difficult to separate Rothbard's analysis of taxation from his anarchism. MacLean quotes Rothbard as stating that Calhoun is correct that public finance is the "keystone." However, Rothbard's stated rationale is that all the other government intervention is funded by taxation. The implication is that if there were no taxation, then there would be no illegitimate government activity, which according to Rothbard, is all government activity. Obviously, whether or not Calhoun really believed that his analysis of taxation was any kind of "keystone," his rationale would be quite different. Calhoun was no anarchist.

MacLean almost immediately takes off into Calhoun's well known support for slavery as a positive good, implying that Rothbard (and Buchanan) would agree. Again, in the very section she cites, Rothbard expressly includes slavery as a type of "binary" intervention into the free market, just like taxation. Rothbard plainly rejected slavery as illegitimate.

Further, Rothbard begins the chapter cited by MacLean, not with Calhoun, but rather with Franz Oppenheimer. A few pages before the pages cited by MacLean, Rothbard's shares his true "lodestar." It is Oppenheimer's distinction between the "economic means" of obtaining wealth through production and exchange in contrast to the "political means" of obtaining wealth through theft and exploitation. Rothbard does little more than introduce the terms in Power and Market, but in his later and more popular work, For A New Liberty, he makes it plain that he sees the genesis of the state in conquest with the feudal overlords exploiting the newly enserfed peasantry (p.61) For Rothbard, slavery is the epitome of the illegitimate political means of obtaining wealth.

Buchanan undoubtedly shared Rothbard's highly negative views regarding various despotic regimes both in the past and in the present. However, Buchanan's fundamental vision of constitutional democracy is that it is a way for people to come together and provide for the production of desirable public goods.

For Rothbard, government is always the master exploiting the slave. As Rothbard's quote from his preface makes clear, he recognized that this is completely different from Buchanan's basic view of government and democracy. Too bad MacLean failed to take note.

However, his major criticism of her work is that it exhibits manicheanism. Her opponents on the right must be entirely evil. Friedman claims that libertarians, and Buchanan in particular, do the same. They treat their opponents as wholly evil. Friedman uses this to share his view that manicheanism is a serious problem of our time. It is common, even typical, to impute base motives on political opponents. This would be as opposed to considering their views being some sort of intellectual error that might be corrected through discussion.

Well...

Friedman identifies libertarian in a narrow way. Perhaps it is best known as the position advocated by Nozick in Anarchy, State, and Utopia, but I describe it as Rand/Rothbard libetarianism. In his premier blog post, Friedman asserts a key position--taxation as theft. But more fundamentally, coercion is counted as an absolute wrong. And that includes violations of property rights. According to Friedman, libertarians are not reflective regarding property rights. Libertarians just assume that private property rights must be inviolate.

Some of this discussion is all about claiming that MacLean just cannot believe that anyone could possibly believe such absurd notions and that explains her view that all the libertarians are being paid by rich people. These rich people benefit from keeping government from taking their private property.

If, instead, "libertarian" is understood in a more inclusive way--including, for example, the view of James Buchanan, then all of this just falls apart. Milton Friedman, F.A. Hayek, Ludwig Von Mises, and Buchanan all supported private property and market exchange because it is beneficial to just about everyone. All of them believe that taxation is appropriate for some purposes.

In other words, none of them just assume that private property rights exist and their violation is evil coercion and none of them take the position that taxation is immoral and must be abolished.

While Buchanan's policy views are in many ways typical for a mainstream libertarian, his political philosophy is a bit unusual. There are no property rights or market exchange in the Hobbesian state of nature, so it is the social contract that creates property rights and freedom for the more mundane contracts that allow for market exchange. According to Buchanan, all must be willing to agree to the social contract that generates the constitutional order. Buchanan favors private property rights and freedom of contract because it will benefit everyone and so it would be sensible for them to agree to it as part of the social contract.

But that doesn't mean that the agreed constitution would prohibit the government from imposing any regulation or collecting any taxes--it is just that everyone benefits from a system with private property and market exchange and with necessary taxation and regulation limited by constitutional rules.

It is also important to understand that in Buchanan's view a sensible constitution will allow for regulation or taxation without a unanimous vote. It is true, however, that 50% plus 1 is not essential. Depending on the issue, it could be more or it even could be less. Not every political decision will benefit everyone, but the system as a whole should be something that benefits everyone so that they are willing to agree to it.

Buchanan strongly believed that constitutional rules should be designed to protect against selfish voters, politicians, and bureaucrats. While such rules may interfere with the ability of well meaning voters, politicians and bureaucrats to do good, he believed that it is sensible to protect against the threat of serious harm by political actors with venal motives.

Does public choice assume that all voters, politicians, and bureaucrats are self interested? That is the near universal analytical assumption as best I can tell. What would happen if they were? And does that pattern of activity fit the data? It is no different from the economic approach to understanding markets. What if firms all maximized profits? What would happen if they did? Does that fit the data?

My view, which I don't think is unusual in the "Virginia School," is that most people are mostly selfish. Analysis based upon the assumption of selfishness will explain much of what happens in society, but not all.

A constitution that will work well if everyone is public spirited but fails in the face of selfishness is a disaster waiting to happen. A constitution that will meet the test of selfish voters and ambitious politicians is not only a safeguard against disaster but will work tolerably well with real people.

My understanding of the market economic system is that it will work tolerably well, even if people are entirely selfish. It is much better than a system of production and consumption that would only work if most people were mostly public spirited. And a market system is better than the alternatives with real people, most of whom, are mostly, though not totally, selfish. I agree with Buchanan that a proper constitution constrains voters, politicians and bureaucrats in a similar way, as best can be managed.

Wednesday, July 26, 2017

My impression of Nancy MacLean's Democracy in Chains is that it is primarily an attack on Charles Koch. The Koch brothers are hardly an unusual target. What is special about MacLean's "contribution" is that she uses James M. Buchanan as a club. Yet another reason for the perfidy of the Koch's is that they are promoting and spreading the ideas of wicked Buchanan. And what is wicked about Buchanan? His ideas are at base little more than strategies to fight civil rights and maintain Jim Crow segregation.

False, but....

Does this book help or harm Buchanan's legacy?

For those of us who would like to see Buchanan's body of work become more influential, I think the answer is that it helps.

There is no such thing as bad publicity. At least that is what P.T. Barnum said.

Friedman and Hayek were subject to hatchet jobs. Buchanan is joining the club of late libertarian Nobel-winning economists. (Bringing the level of attention Buchanan's ideas receive to that of Friedman and Hayek is a good thing in my opinion.)

That a left (far left?) historian trashes Buchanan can hardly hurt him on the right. A leftist tries to paint him as a racist? That is practically a badge of honor.

Surely, the field of intellectual battle is on the center left. And MacLean's careless errors makes her argument against Buchanan very weak.

Her status as an award winning historian at an elite university is more damaging for the reputation of academic history than to Buchanan. The more historians and humanities academics defend her--even claiming that making things up is good practice--the more they destroy their credibility.

I realize that academics seeking Koch money for some kind of university center will see MacLean's book used against them. Maybe it will be the motivation--filtered through leftist professors--for student protests. I admit that these are costs. But let faculty senates discredit themselves. Let university presidents do their jobs.

Is Buchanan some shadowy figure with a secret agenda? Of course not. His actual views can withstand honest scrutiny.

Picking apart MacLean's book is necessary. But don't get mad. See the opportunity.

Tuesday, July 11, 2017

I took two classes with James M. Buchanan. The first was in the late seventies at Virginia Tech and the second in the early eighties at George Mason. He was also a member of my dissertation committee.

Anyway, in class he explained that when he was in the Navy in WW2, he learned to follow instructions completely. After the war, when he was at Chicago, he was given a complete bibliography of Public Finance and he took it to be the class reading list, and so he read it all. (Well, maybe he didn't say he finished it all, but he was working at it when the instructor explained that it wasn't intended to be the reading list for his course.)

Included on that list was a work by Knut Wicksell. Wicksell is a quite famous monetary economist, but he also wrote a book on public finance. Buchanan was especially taken by Wicksell's "A New Theory of Just Taxation." He told us that his contributions to Public Choice were little more than an elaboration of Wicksell's approach.

I think he was being more than a bit too modest, but he didn't mention John C. Calhoun or the Southern Agrarians as inspirations. Looking at his early publications, sure enough, soon after graduate school in the late forties and early fifties he appeared to be applying the Wicksellian insights.

The Thomas Jefferson Center for Studies in Political Economy started in 1957. Here is Buchanan's contemporary description of what it was about.

Nothing there about protecting states' rights or the desirability of segregation. I find it hard to see anything "between the lines." There is just an express support for individual liberty and the free enterprise system.

Nancy MacLean's Democracy in Chains is not consistent with the James Buchanan I met in the late seventies and I have seen nothing that suggests that the early Buchanan was much different.

IHS and the Mercatus Institute had meeting about monetary policy in San Diego on June 25th. I was fortunate to attend.

Scott Sumner was interviewed by David Beckworth for Macro Musings. I suppose we were the live audience. (As I write, the interview isn't up yet.)

In the question and answer period, Sumner was asked whether it would be possible to test out Nominal GDP targeting in some smaller country--say Kenya--rather than hold out for the Fed or the ECB. Sumner said that he was not sure that NGDP targeting is appropriate for a small open economy. The problem is that they may be too specialized in producing a commodity with an unstable world price.

When I spoke to him later, he said that for countries in that situation it is probably better to stabilize nominal labor income. Of course, Nominal GDP is hardly ideal even for a country like the U.S. either. Changes in indirect business taxes, for example, could create problems. A stable growth path for something like total labor compensation might be better for the U.S. too.

But I would like to explore the small open economy issue a bit more. While I can imagine scenarios where shifts in commodity prices might cause problems, I think that the problem isn't really specialization in commodities with unstable world prices.

For example, suppose everyone in a country is a coffee farmer. The country stabilizes the growth path of nominal GDP, so regardless of world coffee prices or local coffee production, nominal income from coffee sales grows at a stable rate.

How is this possible? If world coffee prices rise, the value of the currency rises enough so that the domestic price of coffee remains the same. Nominal incomes remain the same and imported goods become cheaper.

If, on the other hand, coffee prices fall, the value of the currency falls enough so that the domestic price of coffee is unchanged. Nominal incomes are the same, but imported goods become more expensive.

Complete specialization in producing a commodity with an unstable price looks like no problem--other than menu cost of all of the shops changing the prices of imported consumer goods.

Now, lets add a bit more realism. Who is operating the shops full of imported goods? What about haircuts? What about home construction?

If the world price of coffee rises, at first pass, the currency rises in value so that the domestic price of coffee is the same. Nominal income for the coffee growers and nominal income in the nontraded sector is unchanged. The imported goods in the shops are cheaper. If the income and substitution effect for nontraded goods exactly offset, then that is all. In other words, if the increase in the demand for nontraded goods due to the higher real incomes is equal to the decrease in quantity demanded due to their higher relative price compared to imports, then the distribution of nominal income and the allocation of resources remain unchanged.

However, if the income effect is greater than the substitution effect, the currency must rise more than in proportion to the world price of coffee so that the domestic price of coffee falls, reducing nominal income in the coffee sector. The profitability of coffee falls a bit, freeing up resources to provide more nontraded goods. If nothing else, somebody is going to have to handle the increased volume of the imported goods coming in. Nominal income in the nontraded sector increases.

The less pleasant scenario for this nation of coffee growers is a decrease in the world price of coffee. The currency falls in value and, at first pass, the domestic price of coffee is the same as is nominal income in the coffee sector. Imported goods in the shops become more expensive. If the income and substitution effects exactly offset, nominal incomes in the nontraded sector are unchanged, but real incomes fall just as they do for coffee growers. There is inflation of consumer goods prices--particularly the imported ones. If income effect is greater than the substitution effect, the currency will fall enough to raise the domestic price of coffee, making coffee growing more profitable, expanding the demand for labor and other resources no longer needed in the nontraded good sector.

The situation where the substitution effect is greater than the income effect is a bit inconsistent with the conventional terminology of "nontraded goods sector." The analysis is no different from a situation where there are import competing industries. If the world price of coffee rises, the currency rises, and the now cheaper imports result in lower demand and lower nominal incomes in the import competing sector. The currency, therefore, must rise less than in proportion to the world price of coffee, such that domestic coffee prices and nominal incomes in the coffee sector rise an amount that offsets the decline in the prices of import competing goods and the resulting decrease in nominal income in that sector. Profitability in the coffee sector rises drawing resources from the import competing sector into the production of coffee for export. Of course, import prices are cheaper, making the effect on real incomes in the import competing sector somewhat ambiguous, but real income rises in aggregate because of the improved terms of trade.

If the world price of coffee falls, the currency decreases in value. The demand for import competing products rises, resulting in higher prices and higher nominal incomes in that sector. The decrease in the value of the currency is dampened then, so that there is a decrease in price and nominal income in the coffee sector that offsets the increase in spending and nominal income in the import competing sector. The increased profitability of the import competing sector creates an incentive to pull resources away from coffee production to the production of goods for domestic consumption. With the higher prices of imported goods, real incomes in the import competing sector are ambiguous, though aggregate real income falls with the less favorable terms of trade.

It is these considerations that suggest to me that nominal GDP targeting might well be appropriate for a small open economy specializing in the production of a commodity with an unstable world price. What is Sumner's concern?

Consider a situation where our small open economy has a giant copper mine or maybe a giant diamond mine. The product makes up approximately all exports and a substantial portion of GDP, but directly generates little employment.

If the world price of copper increases, then the value of the currency increases, the domestic price of copper is unchanged and imported goods are cheaper. If the income effect is greater than the substitution effect for nontraded goods, then the price of copper rises somewhat less so that the domestic price of copper is less and so nominal income generated by copper falls, making it slightly less profitable to produce so that fewer workers are needed and they can be shifted to the nontraded sector where prices and nominal incomes rise. Of course, with the assumption that there are very few copper miners anyway, and the other resources useful for copper mining might not be very useful in other endeavors, this adjustment in relative nominal incomes might provide what is superficially the correct signal and incentive to reallocate resources, but there just is not much reallocation possible. There has just been a pointless inflation in the nontraded goods sector.

If the world price of copper falls, this problem is even more apparent. The value of the currency decreases. At first pass, the domestic price of copper is unchanged. Imported goods are more expensive. If the income effect is greater than the substitution effect, the value of the currency decreases by less, the domestic price of copper actually rises a bit, nominal income in the copper industry rises, and nominal income in the nontraded sector decreases. This provides the signal and incentive to shift resources from the nontraded sector to copper production. But if copper production generates few employment opportunities, the result is that there is really just a pointless deflation of prices and wages in the nontraded sector. Compounding the pain in the nontraded sector, there is substantial consumer price inflation due to higher import prices.

Inflationary recession in most of the economy, while the copper mine earns more nominal profit. If the copper mine were privately owned, this would be a political disaster.

If there are import competing industries, these problems are exacerbated. With an increase in the world price of copper, the value of the currency rises, with nominal income rising in the copper sector while falling in the import competing sector. While this provides a good signal and incentive to shift more resources to copper production, by assumption that happens to a minor degree. Again, there is mostly just a pointless deflation of prices and wages in the import competing sector.

If the world price of copper falls, the currency falls in value. Prices and nominal income in the import competing sectors increase, while the domestic price of copper and nominal income in the copper industry decrease an offsetting amount. While this provides the proper signal and incentive to shift resources from copper production to import competing industries, by assumption, there is little opportunity for such an adjustment. The result is just an unnecessary inflation in prices and wages in the import competing sector. Of course, rising import prices imply consumer price inflation anyway.

If there are other export industries along with copper, for example, fruit, an increase in the world price of copper and the resulting increase in the value of the currency will reduce domestic prices and nominal incomes in these other export industries. While this would provide an appropriate signal and incentive to shift from the production fruit to copper, again, the possibility for such a reallocation of resources is limited by assumption. With a decrease in the world price of copper, the reduction in the value of the currency will result in higher domestic prices and nominal incomes in other export industries.

Consider a scenario where the copper mine is on a distant offshore island. The mining is done by a foreign multinational with expatriate workers from other parts of the world. Leaving aside any income the government collects from this enterprise, does it make any sense to include the nominal output of this operation when determining an appropriate monetary policy for the mainland? It would seem more appropriate for monetary policy to stabilize nominal GDP for the mainland while ignoring what is happening in what is effectively a foreign industry.

Sumner's suggestion that total labor compensation be stabilized would probably help solve the problem where an export generates a substantial part of GDP and little employment. But more generally, the problems I see with nominal GDP targeting in this context involves the specificity or substitutability of resources in production of various goods. My coffee example assumed labor and resources could be shifted between coffee and other products-nontraded, import-competing, or other exports. My copper example assumed that this was nearly impossible.

I believe this is related to the notion of an optimal currency area. The example of the copper producing island causing pointless disruption on the mainland makes this plain. The island and mainland do not make an optimal currency area. Regardless of its geographical location, however,, the same issues apply. Regardless of the location of the copper mine, perhaps it is better to stabilize the growth path for nominal production for the rest of the economy (nominal GDP less final copper output.)

But nominal GDP targeting, does not, in general, result in problems when countries are specialized in the production of a commodity with an unstable price. In the extreme, where all that is produced is such a good, it works quite well. And it also works even better when resources can be shifted between the export sector, the nontraded sector, the import competing sector, and other export sectors.

Now, it might be that stabilizing the growth path of nominal labor compensation would do ever better. But nominal GDP targeting would work better than stabilizing the exchange rate or consumer price inflation.

Saturday, July 8, 2017

I recently read a claim that employers have unfair bargaining power relative to employees. The reason is that the employees need money right away while the employers don't need workers right away. I have certainly heard such a claim before, but it recently struck me that it is silly.

I certainly agree that many workers need a job right away. And I also agree that many employers are unlikely to be desperate to fill a vacancy--particularly if an employer has many employees.

Of course, this is not always true. Not all workers are so desperate and some employers may be brought to a standstill without a key employee.

But let us suppose that a currently unemployed worker accepts an unfairly low wage because he needs the money now and cannot hold out for a fair wage. The employer would be willing to pay more, and if the employee just waited a bit, the employer would offer more. But the employee cannot. He must eat.

Now, the unemployed worker is employed. Earning an unfairly low amount by assumption, but presumably no longer desperate.

So now the unemployed worker can look for a new job. He doesn't have to quit, become unemployed, and then look for a new job. He can seek this new job while continuing to work.

Now, the claim that the workers have nothing and need money right away no longer applies. This worker can continue to work at his current pay until a better offer comes along.

Is this realistic? Do firms actually hire the employees of other firms? Do people accept a new job while they are currently working for an employer? Or is that sort of thing quite rare, with employers generally hiring those who are unemployed and most employees only obtaining a new job if they have been laid off or fired from their previous job?

There about 150 million people employed right now in the U.S. and there are about 7 million unemployed people. Hires are over 5 million per month. More people are hired in two months than are unemployed today.

Quits are about 3 million per month. That is 36 million per year.

Do all of these people become unemployed? Of course not. For the most part, these are people who have been hired while they already have another job which they then quit.

There are many reasons why someone might quit one job and take another, but a key reason is better pay and benefits. Of course workers leave one employer and go to another that offers a better deal. Of course employers will hire currently employed workers. In fact, there is evidence that they discriminate in favor of the currently employed.

If the desperation of unemployed workers to take anything was important to employers you would expect that they would be most anxious to hire the unemployed. But they aren't. That suggests that employers do not obtain a benefit from this sort of bargaining power.

Layoffs and other discharges are about 1.6 million per month. Almost certainly, they add to the pool of unemployed. (In 2009, layoffs and discharges were almost 2.5 million per month.) If it weren't for new hires, in 10 years, everyone would be unemployed! But, more people are hired than lose their jobs. That is why employment grows. In the last decade or so, it rises about 200,000 each month because total hires are greater than total separations.

The point of these figures is to understand that the labor market cannot be identified with people losing their jobs, being desperate to find work, and then employers finally hire the unemployed. While that is part of the story, workers being hired away from one employer by another is very significant--more significant.

The pace of new hires is very important. In 2008 and 2009, new hires dropped significantly. While there was plenty of hiring--3.5 million a month--that is a lot less than 5 million. During the year or two when it was worst, something like 70 million people were hired. But these days more than 100 million people would be hired over a similar period of time. That makes a big difference.

As mentioned above, layoffs jumped up too--close to the number of hires. But the rest of the story is that quits dropped off tremendously, to less than 2 million per month. Why? Most likely because firms were hiring less, and that mostly means hiring fewer people away from other employers. Current employees quit less often since there are fewer new, better job to take.

When labor demand is strong and growing, wages rise from employees switching employers. When labor demand is weak and there are few hires, then wages stagnate.